In a world of increasing cost pressures, supply chain finance emerges as a way to manage risk, boost efficiency and ensure a steady supply of working capital. But what exactly is it, and why should companies, big or small, give it a second glance? In this blog, we'll explore what supply chain finance is, how it functions, and the benefits it offers. By the end, you'll gain insights into its processes and be able to make an informed decision over whether it is right for you.
What is supply chain finance?
Supply chain finance is a payment strategy designed to increase liquidity and cash flow for suppliers and buyers. It allows suppliers to receive early payments on invoices, providing them with immediate access to working capital, and extends the time before buyers have to pay, by introducing a financial institution as an intermediary.
How does supply chain finance work?
Once a buyer approves an invoice, a financial institution steps in to pay the supplier, often in full. The buyer, in turn, repays the financial institution under agreed-upon terms at a later date, thereby extending their payment period.
The process begins with the establishment of a contractual agreement between the involved parties. With digital platforms, automation ensures that the approval of invoices is swift and transparent. Suppliers get paid almost immediately upon approval, while buyers get the luxury of extended payment terms.
This mechanism is built upon collaboration between buyers, suppliers, and financial institutions. It capitalises on the buyer's creditworthiness, allowing suppliers to access money at lower rates than they would independently.
Benefits of supply chain finance for buyers
- Hold onto cash for longer
Supply chain finance takes the urgency out of payments for buyers, meaning they have more flexibility to pay when convenient. Working capital is kept in the business longer to improve cash flow.
- Stronger relationships
Offering early payments at reduced rates can solidify partnerships and secure favorable terms, like better prices, discounts on large orders or reduced shipping times. Buyers can also remove worries about damaging the relationship due to late payments.
When transactions are backed by financial institutions, there is reduced risk of supplier failure. This stability allows buyers to focus on strategic growth rather than financial uncertainties within their supply network. Buyers can also invest more comfortably in smaller suppliers – enjoying the dedication and agility offered by a smaller business without as much of a risk factor.
- Supplier management
Depending on what financial methods are chosen, supply chain finance can minimise the administration involved in managing suppliers. If all payments are routed through one supply chain finance system, supplier relationships can be easier to manage.
Benefits of supply chain finance for suppliers
- Reducing risk
Over half of manufacturing firms have experienced delayed payment. When the money from payments is crucial to funding continued operations, these delays have the potential to stop a business in its tracks. Smaller or newer businesses especially do not have the reserves of ready capital to continue functioning if they are not receiving the cash they have planned for. Over half (55 percent) of SMEs say that the problem is worsening, with late payments increasing over 2023. Delayed payments can result in businesses being unable to fulfil orders or pay their staff.
Supply chain finance introduces a level of security, as transactions are guaranteed quickly and can be relied upon, as they are backed by financial institutions. There is less of a risk of a company suddenly finding itself in a cash-strapped position, with a greater chance of the business achieving long-term financial viability.
- Future planning
When payments can be relied upon promptly, businesses can maintain a more accurate forecast of profits and capital. In other words, they know what spare cash they have “to play with” as they continue on their growth journey. New projects and orders can be planned for, secure in the knowledge that the money will be there to fund them. There is more likely to be money to invest in innovation and efficiency, turbocharging a business’s growth journey.
- Improve financial health
With supply chain finance, suppliers are less likely to have to rely on other methods of securing capital, like debt financing – where a company borrows money and then pays it back with interest – or use of a business credit card. These types of financing are typically subject to higher interest rates and worse terms than supply chain finance, where the trustworthiness of the buyer usually means that the capital can be accessed at a lower rate than other sources. It is a good way to avoid the escalation of debt.
Challenges of supply chain finance
- Fees
The financial institutions enabling early payments will extract a fee, which is usually between ten and twenty percent. Companies must weigh this up against the increase in liquidity and consider its bite into profit margins, especially for large deals.
- Dependence on buyer credit
Supply chain finance relies heavily on the buyer's credit worthiness. Any change in the buyer's financial status could impact the program. There is an element of risk that your buyer will suffer financial issues and require a reversion to classic supplier/buyer relationships at short notice.
- Supplier participation
Not all suppliers will be able to participate, as supply chain finance is typically only offered to businesses that have been trading for several years, with a good credit history. This may rule out start-ups and businesses that have suffered from financial challenges in the past.
Conversely, the fee might make supply chain finance a false economy in some cases, when suppliers already have strong financial stability and do not require early payments.
- Implementation complexity
Setting up and managing supply chain finance can be complex, requiring collaboration between various stakeholders, including financial institutions.
Supply chain finance in manufacturing
In the manufacturing sector, supply chain finance can play a crucial role in ensuring smooth operations and improving resilience. Manufacturers often deal with long production cycles and seasonal demand fluctuations, making cash flow management critical. By implementing supply chain finance, manufacturers can better manage their working capital, maintain optimal inventory levels, and invest in new technologies to enhance production efficiency.
Supply chain finance in logistics
Logistics companies are integral to the supply chain, responsible for moving goods from one location to another. Supply chain finance can help these companies manage their cash flow challenges, such as fluctuating fuel prices and maintenance costs. By optimising payment terms and accessing early payments, logistics providers can maintain efficient operations and invest in fleet upgrades or route optimisation technologies. Supply chain financing can help bridge the gap when there are long delivery delays – making sure that the logistics firms are paid even if the shipment is delayed by geopolitical hold-ups outside of the transporter’s control.
Supply chain finance is more than a financial instrument; it's a strategic enabler in today's competitive business landscape. By understanding and implementing it, both buyers and suppliers can unlock significant benefits, from enhanced cash flow to stronger partnerships.
Supplier & Contract Management ensures that you maintain accurate and auditable supplier information at all times, allowing you to more easily assess opportunities for leveraging supply chain finance.